Annette Heuser speaks on why the big three credit rating agencies don’t have to have a stronghold on sovereign ratings at TEDGlobal 2013. Photo: James Duncan Davidson

By Annette Heuser

Eight months after my talk at TEDGlobal 2013, much progress has been made on the International Non-profit Credit Rating Agency (INCRA) concept. The progress, however, has not been in the credit rating agency world itself, which is slow to change, despite strong criticism from political officials and, occasionally, the media.

You may recall the public outrage over ratings at the height of the Euro Crisis in 2011 and 2012. Then, the so-called “big three” credit rating agencies ― Standard & Poor’s, Moody’s and Fitch ― downgraded the US and several European countries. Dramatic headlines renewed public interest in sovereign ratings and the institutions that produce them.
Annette Heuser: The 3 agencies with the power to make or break economies
The attention inspired me to think about a new way to address the sector’s deficiencies. Instead of approaching the problems from a regulatory angle, I developed an institutional model to addresses the shortcomings of this sector’s major players. Transparency and accountability: those are the key components for higher-quality sovereign ratings.

A few colleagues have called me crazy when I told them about my idea for a non-profit credit rating agency for sovereign risk. I took their skepticism as a challenge to see if the INCRA concept could work. In recent months, it’s begun to look more and more possible. At the Bertelsmann Foundation we consider ourselves to be a “think and do tank,” and we feel strongly committed to INCRA.

Recently, we have made progress towards demonstrating that it is possible to establish a non-profit structure for a rating agency in the US. We’ve continued to increase our global network of like-minded credit rating agency reformers who support the INCRA mode. We’ve increased awareness of INCRA among international policymakers and investors in sovereign bonds. And we’ve rallied support from potential INCRA investors in the corporate and public sectors. We are taking an active role in promoting the concept and determining if there is a level of support sufficient to make INCRA a reality.

But why are sovereign ratings important in the first place, you ask?

First, sovereign ratings help assess an enormous market. The value of outstanding sovereign bonds dwarfs that of all other bonds by a huge margin.

Second, as I explain in my talk, the ratings of these bonds affect each of us directly as citizens and taxpayers. Ratings assess a government’s ability and willingness to repay debts. As we have seen in the past, a downgraded government generally must contend with higher borrowing costs. This can translate into higher taxes, cuts to vital government programs and slower economic growth, changes that negatively affect the citizenry. Since sovereign ratings impact us all, I believe that they should be defined as “public goods,” something that is available to all citizens.

This is why my ratings team at the Bertelsmann Foundation has invested considerable time and effort into trying to create a model to address the conflicts of interest and lack of transparency in the ratings process, as well as the inability for the public to determine ratings criteria. The INCRA model would also ensure a truly international entity — not one that could be perceived as American or European. INCRA would give emerging economies and developing countries a role equal to that of industrialized nations. And it would be revolutionary to run a credit rating agency as a non-profit and focus solely on sovereign risk.

INCRA would differ from existing credit rating agencies in both its institutional set-up and its rating methodology. It would operate from a sustainable endowment or on an annual budget. It would rate countries worldwide at no cost to rated entities (governments) or to parties interested in reading the rating reports (e.g., investors). And INCRA would improve the quality of ratings by employing a new set of indicators and making clear how each factors into the overall rating. In addition to the traditional macroeconomic indicators, INCRA examines a comprehensive set of so-called “forward-looking indicators” that mirror a country’s socio-economic development. They assess, for instance, a government’s willingness to invest in education, its crisis-management capabilities, its overall political management and its ability to communicate policies. These are highly relevant, qualitative factors for a solid analysis of a government’s ability and willingness to repay debt, which is the focus of sovereign ratings.

In a nutshell, INCRA is designed to decrease the power of the oligopoly of the “big three” credit ratings agencies by increasing competition; establish a precedent for non-profit players operating alongside traditional, for-profit players; minimize conflicts of interest (and appearances of conflicts of interest) by providing sovereign-debt ratings to the public for free; increase the transparency of the rating process and its outcome; and increase the quality of sovereign ratings by introducing more qualitative indicators.

This project is not a sprint. It is, rather, a marathon to establish INCRA as a cornerstone for a more inclusive international financial system. Although it requires significant effort and stamina, the rewards of running a marathon are great. As Thomas Edison said, “There is no substitute for hard work.”

I hope that you’ll join us in supporting INCRA’s journey to the finish line.

Sovereign credit ratings are kind of like Consumer Reports for nations — just as people read car magazines or washing machine reviews before buying, investors read ratings to determine how to invest their money. Sovereign credit ratings assess a country’s debt and its ability and willingness to repay it. And whether citizens of a country realize it or not, a downgrading of even a single point can have serious ripple effects. If downgraded, a country has to pay more to borrow money on the international markets, meaning that much less is available for roads, schools, healthcare and other services.

On the TEDGlobal 2013 stage, rating agency reformer Annette Heuser suggests that sovereign credit ratings, because of their impact on the wider public, should actually be treated as public goods. She sounds a warning bell that these ratings are dominated by three players: Standard & Poor’s, Moody’s and Fitch Group. This raises three big issues:

There’s little competition in the sector, and thus agencies have little incentive to improve.

Countries are the customers of these agencies. They pay for their own ratings, and that creates a conflict of interest.

There’s very little transparency, and we don’t know how exactly these companies formulate their ratings.

“We are allowing rating agencies to be intransparent about their work. We need to change this,” Heuser says. “The sector needs a complete overhaul, not just a trimming around the edges.”

Photo: James Duncan Davidson

Heuser’s solution: add a nonprofit to the mix. She proposes an international nonprofit credit rating agency, INCRA, that would be funded by a sustainable endowment, that would make its methodology transparent, that would make its ratings publicly available — and that would create competition in this sector to force improvement. Some key differences that INCRA would offer: It would avoid conflicts of interest through being an international agency, with emerging economies having an equal voice in decisions as established ones. And it would do its risk assessment based on forward-looking indicators — for example, looking at how countries are investing in education and renewable energy, as well as their ability to implement reforms during a crisis. High youth unemployment? Well, that would be factored in as a current problem as well as a future one, since it will have an effect on economy in coming years.

INCRA is currently testing its model, and Heuser is hopeful that it could be a game-changer.

“Sovereign rating may look like small piece of the global financial world, but I tell you it’s an important one to fix,” says Heuser. “We have the unique opportunity right now to turn INCRA into the cornerstone of a new inclusive financial system. We’ve left the major financial players alone for too long.”

]]>http://blog.ted.com/rating-the-ratings-agencies-annette-heuser-at-tedglobal-2013/feed/1TG2013_031613_D31_3944katetedTG2013_031896_D41_1244TG2013_031613_D31_3944Money Talks: The speakers in session 4 at TEDGlobal 2013http://blog.ted.com/money-talks-the-speakers-in-session-4-at-tedglobal-2013/
http://blog.ted.com/money-talks-the-speakers-in-session-4-at-tedglobal-2013/#commentsWed, 12 Jun 2013 07:20:24 +0000http://blog.ted.com/?p=76311[…]]]>In the immortal words of the Wu-Tang Clan, “Cash rules everything around me.” Then again, as Benjamin Franklin put it, “A penny saved is a penny earned.” So how are we to parse this thing — money — which shapes so much of our lives? This session will make you think again about economics, taking a deep look at how cash flow effects individuals, countries and where we’re headed in the future.

Here are the speakers who took the stage during this session of TEDGlobal 2013. Click their name for a full recap of their talk:

In “Plutocrats,” Chrystia Freeland explores the growing gap between the working poor and the increasingly disconnected mega-rich.